The Lego Movie Economy

Summary:
A Lack of “V”
After the February jobs report, President Obama said “America’s pretty darn great right now.” He then went on to disparage the “doomsday rhetoric” of the Republicans, which he said was pure “fantasy.
I think that there is a good chance that this will enter the Hall of Fame of miss-timed statements, right up there with this jewel from Ben Bernanke in March 2007: “At this juncture, however, the impact on the broader economy and financial markets of the problems in the sub-prime market seems likely to be contained.”
If you look hard enough, you’ll find it…
It is about time for an update on the US economy. It will be a bit pointillist, but I will try to give some backing.
My basic view of the US economy is the following: We have never had a proper recovery from the global financial crisis (“GFC”). Although GDP is above its peak prior to the GFC, the rebound has been very muted, particularly given the sharpness of the fall, which has historically produced a “v-shaped” rebound. There has been no “v” in this reco-ery.
The jobs growth, although seemingly impressive in terms of the headline unemployment rate, has remained un-validated in a whole variety of ways. The labor force participation rate, which normally would increase in the face of improved job prospects, has remained very low in a way that cannot be fully explained by demographics.

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A Lack of “V”

After the February jobs report, President Obama said “America’s pretty darn great right now.” He then went on to disparage the “doomsday rhetoric” of the Republicans, which he said was pure “fantasy.

I think that there is a good chance that this will enter the Hall of Fame of miss-timed statements, right up there with this jewel from Ben Bernanke in March 2007: “At this juncture, however, the impact on the broader economy and financial markets of the problems in the sub-prime market seems likely to be contained.”

If you look hard enough, you’ll find it…

It is about time for an update on the US economy. It will be a bit pointillist, but I will try to give some backing.

My basic view of the US economy is the following: We have never had a proper recovery from the global financial crisis (“GFC”). Although GDP is above its peak prior to the GFC, the rebound has been very muted, particularly given the sharpness of the fall, which has historically produced a “v-shaped” rebound. There has been no “v” in this reco-ery.

The jobs growth, although seemingly impressive in terms of the headline unemployment rate, has remained un-validated in a whole variety of ways. The labor force participation rate, which normally would increase in the face of improved job prospects, has remained very low in a way that cannot be fully explained by demographics.

US labor force participation rate: flashback to the 1970s – click to enlarge.

Wage growth has been anemic, including a negative print in the hourly wages and hours worked in the report just lauded by Obama. Productivity has also been poor, even though this statistic normally responds in a highly pro-cyclical manner: in the 4th quarter of last year, it sank at one of the fastest rates in decades.

As I also pointed out in the “A Job Is Not a Job Is Not a Job” section here, much of the employment growth has been in low-earning and low-hours positions, a trend that continued with the February report. Finally, the allegedly booming jobs market has not been validated by a sharp fall in, for example, the number of families participating in the Supplemental Nutrition Assistance Program (“food stamps”).

As David Stockman has pointed out in another of his lacerating comments about the jobs scene and the official statistics, the reported figures are subject to a vast amount of estimation and seasonal and other adjustments. Even in the most stable of times, these make the numbers suspect.

At cyclical turning points, such as we may now be experiencing, they go from the suspect to the indicted; they are frequently massively revised downward after the smoke has cleared. This fact, combined with the lagging nature of employment, means that we should not be overly cheered by the latest figures.

Stockman and others tend to look at the payroll withholding taxes sent to the IRS as being a better indicator of current trends in employment, since these figures are not distorted by estimation and they proportionately reflect part-time and low-income employment.

As the chart about midway through the Stockman article shows, these figures have been flat in nominal terms, indicating that real labor input has been falling since the end of last year. This, to me, is some of the strongest evidence against the White House version of Everything is Awesome.

Finally, we have one of the biggest counter-indicators of all, which is the strong showing of political outliers such as Trump and Sanders. This is not the behavior of an electorate basking in a “pretty darn great” economy.

Pockets of Bubbliness

The recovery hasn’t been validated in other ways, too. Capital expenditure has been very weak, something that we also would not have expected. Corporate earnings have increased greatly from the bottom, but this trend stopped last year and the trailing figures have now turned sharply downward.

The overall weakness of the US economy since the GFC has been partially masked by pockets of bubbliness. Like the tide, these are now in full retreat, leaving an economy that looks like a bunch of unclothed bathers.

The fracking boom, which lived off cheap credit and accounted for a large part of the growth of high-paying jobs and capital expenditure, is now in full rout along with the junk bond market that drove it. Record numbers of shale rigs are idled.

One area in which bubble activities have deflated rapidly

Likewise technology, which converted abundant VC funding into demand for software engineers, San Francisco and Silicon Valley real estate, and technology equipment, none of which could have been paid for out of non-existent earnings. This spigot has now been turned off and the pink slips are flying.

It now looks like lenders have scraped the bottom of the credit barrel, which means that this one-time boost to consumption is over: recent inventory figures, which show the highest level of auto inventory to sales since the GFC, indicate that the industry may have gotten the memo late. Again. In fact, the inventory to sales ratio for the entire US economy is also the highest number since the GFC.

Our old favorite, real estate (particularly in coastal or “gateway” cities around the world), had also been bubbly. This is now over. As I indicated before, this canary in the coal mine is now looking decidedly sickly. Upper end house markets are turning down in prices like London and New York City, and undoubtedly with a vengeance in San Francisco and Silicon Valley.

My contacts within the UK commercial real estate market indicate that rental growth and cap rate compression have come to a full stop, and the UK institutions are looking to dump their real estate holdings onto backward-looking foreigners.

A minute of silence for those no longer with us…

Weakness Around the World

The US can, of course, expect absolutely no help from the rest of the world. Seventy percent of the manufacturing PMIs around the world declined in February. International trade is collapsing, including the latest prints from China, which showed sharp falls in exports and imports, numbers validated by the figures coming out of other countries in the region. This is another sickly canary.

The emerging markets are in a shambles, led by the former BRIC stars. Japan goes in and out of recession with the blink of an eye. Europe is growing slowly, at best, with some major black swans circling (Brexit, the migrant crisis, populist parties, unresolved Greek debt issues, unstable or un-formable governments, continued rumblings out of the banks, etc.).

Global manufacturing: in a downtrend since 2014 (i.e., since the “tapering” and eventual end of QE3) – click to enlarge.

I put the probability of a US recession this year at 50% to 75%. If it weren’t for the possibility of strong consumption growth, aided by low energy prices, I would put the probability even higher. But I don’t think that even this will be enough since the added fillip of increased borrowing is unavailable.

The recession should be strongly manifest just at about the time US voters are entering the polling booth. The Democrats got their timing right in the 1992 and 2008 elections, but I don’t think that they will be lucky this time around. Hillary Clinton may come to regret her decision to run on Obama’s economic record.

is an American who has lived in Europe for over 20 years, now based in the UK. Although basically retired now, he previously had senior positions at Goldman Sachs, Deutsche Bank, Merrill Lynch and his own firm, initially in structured finance and latterly in principal and fiduciary investing, focussing on real estate. He has a BA in Economics from Bowdoin College (summa cum laude) and an MBA in Finance from the University of Michigan (highest honors).